Sep 20, 2010

US Really Getting Out Of Recession? Cross Sectional View Of Key Economic Measures

Recent improvement in some of the macroeconomic indicators are signaling positivity for the majority of investor public. Even National Bureau of economic research has stated the end of the recession started second half of 2007. From theoretical point of view if we have at least two consecutive positive growth quarters we have expansion and opposite for recession. Last recession is perceived to be the longest since great depression with 18 months length. 

Recent big market move since March 2009 is calculating sharp recovery. And it did happen, but is it sustainable? Improvement in macro indicators tend to lag after significant government intervention in the economy. This lag is 6 to 9 months. It is visible with the last bailout plan announced October 1, 2008. Just 6 months later (March 2009) the markets started improving sharply (as they fell) calculating strong recovery. Macro indicators started improving few months later. But reality now is different. The bailout effect has expired and government stimulus has gone so it is the moment at which the economy is showing its real face. Looking back in the previous two recessions GDP growth usually shows second slowdown in the middle of recovery. That is the point at which reality meet high expectations. Investors realize that this moment boom is government driven. As it often happens economy is not so bad as it is thought to be and not so good as we would like to be. The truth is somewhere in the middle.

Let’s examine change in selected US macro indicators and their relation to stock market moves represented by broad index S&P500. This will help us determine at which point of the cycle we are and what to expect.  Time series include period from 1980 to date for quarterly data for GDP growth, monthly federal funds rate and CPI index data showing change on a yearly basis.

The period includes four recessions: July 1980 – November 1982, July 1990 – Mar 1991, Nov 2000–Oct 2001 and last one: Dec 2007 – June 2009. Common in all of them is fall in GDP growth followed by fall in interest rates. The exception is 1990-1991 recession where we have rising inflation because of the 1990 oil price shock triggered by Iraqi invasion in Kuwait. The fall in interest rates is preceded by fall in stock markets. After the recovery of GDP growth supported by prolonged period of time with lower interest rates, the GDP number has short retreat. As mentioned above this is post recession effect. During temporary GDP pull back investment and capacity rise without real rise in demand. This gap is leading to subsequent slow down, but the recovery is still on track.

Closer look at last two recessions gives detailed information. Nov 2000–Oct 2001 recession was triggered by dot-com bubble burst. This slow down, although not the biggest in GDP numbers, has left stock markets suffering for a long time. GDP started recovering end 2001 while S&P500 turned bullish mid 2003. Interest rates were kept low almost two years and many blame that Greenspan’s decision for pumping sequential bubble – the housing bubble, which led to current crisis.

Although started as a purely financial it shortly became economic crisis leading to 18 month recession – the longest since great depression. During that period inflation has peaked over 5% and then dropping significantly to -2.10% at the beginning of 2009. This raised question for deflationary pressure. Again this was oil price effect as it dropped from $148 Jul 2008 to $35 Dec 2009. The reason: world economy slow down hurts oil demand. Still housing sector has way to recover as prices are highly deflated from their April 2006 peak. The drop in Case-Shiller Composite index since April top up to date is 29% although there is some recovery, which is positive sign. As seen in the chart this is supported by GDP recovery.

Move of the stock market is perceived to be a measure for the overall economy. First chart proves it. Of course one should consider its inefficiencies and overreactions in both market directions. Interesting pattern seen in last two recessions is that bear market starts when interest rates begin declining. The drop in markets ends when interest rates bottom. From this point of view we can consider we have new long term bull market started. At this point we are on its first test. Usually stock markets trade expectations for future path of the economy. So markets have calculated the recovery and now are in idle position. As mentioned above and according to many economists we should expect slow down in GDP growth. This view is consistent with previous recession, where after weak recovery the growth slowed before continued its rise. If this is the pattern now we should expect minor pull back in growth and in stock markets. Of course the type of both recessions is different and the causes for them are, but the recovery pattern should be the same since the stagnation during that period affected all sectors with no exception. One significant difference from last recession to any other is the debt level. The main burden to growth now is debt ratio. Is has been constantly rising last years reaching unsustainable levels. Now economy is entering period of personal debt deleveraging, which means lowering debt levels by shorting consumption. This is weighing on aggregate demand and hence GDP growth. The debt issue concern not only private but also public sector.


All government stimulus programs has led to significant rise of public debt. In other words printing money. This not only leads to unsustainability but lowers the dollar value and inflates the precious commodities like gold. And it is seen in the recent precious metal price. It broke $1350 and it will continue climbing further considering that facts.

The recovery is imminent. The question is at what pace it will move. Current market level has priced sharp recovery and if new numbers are not satisfactory we could see another major market correction. 

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